[WSJ - Heard in the Northwest: GST Telecommunications Has Ills, But Fiber Network Sure Isn't One]
November 10, 1999
Investors might not want to hang up on GST Telecommunications just yet.
A disappointing third quarter and a shareholder lawsuit have pummeled the Vancouver, Wash., company's shares, which are down to $8.50 from a 52-week high of $17.94 in July.
Upbeat analysts, however, note that GST's financial woes concern units it is selling, and that the lawsuit is related to issues which have been debated in court before and which were settled in GST's favor.
What investors should focus on, these analysts say, is the company's 5,900 miles of fiber-optic cable, most of it between Seattle and San Diego -- a market with a huge appetite for Internet service and data transmission. That network, which posted 35% revenue growth from the second quarter to the third, may become such an attractive asset that GST could be acquired by an established phone company before the operation starts to pay for itself, says Stuart Conrad, an analyst with Deutsche Banc Alex. Brown Securities in Atlanta.
"You're talking about a company with an $800 million network in all the right places and with a market cap under $350 million," Mr. Conrad says. "That potential is not reflected in the stock price," he says, which instead reflects Wall Street's disappointment with the pace of the turnaround effort GST began more than a year ago.
Mr. Conrad agrees a lot is riding on that effort. Though he rates the stock a "strong buy," with a 12-month target price of $24, to get there, he says, GST will have to dump more of its marginal businesses, which he says are weighing on its performance "like dragging an anchor through the mud."
GST began taking its current shape in the early 1990s, when IG Investments, a private capital-management firm in Toronto, took over a small publicly traded mining company called Green Star and used it to acquire a variety of telecommunications companies, including GST. Over time, GST's vision of a data highway paralleling Interstate 5 -- the main route linking the West Coast's largest cities -- became of increasing interest to Green Star, which adopted GST as its name and moved into GST's headquarters in Vancouver. IG Investments still controls 7.6% of the company's stock.
To finance construction of its West Coast network, GST sold four debt offerings between 1995 and April 1998 totaling $1.1 billion with interest rates of between 10.5% and 13.875%. Last year, it also issued $50 million in preferred stock to Princes Gate, a Morgan Stanley-led investment partnership that includes Microsoft Chairman Bill Gates and several other Microsoft executives.
But meantime, compared with the promise the new network held, pieces of the original GST began to look like warts. GST operated phone companies in Guam and Hawaii, and an international company called Global Light, which was developing fiber networks in Mexico and elsewhere. And poor results from these businesses, combined with the more than $200 million a year the fiber-optic network was costing, led to a 1998 loss of $154.7 million, or $4.52 a share, on revenue of $158.6 million.
That same year, Joe Basile was named president of GST, and set as his goal the shedding of the marginal businesses and making the network pay. Already, Global Light and the Guam business have been sold. And this winter, GST expects to sell its Hawaiian unit, which is valued at as much as $80 million.
Several of the old businesses -- dubbed by management the "legacy acquisitions" -- remain, however, and in the past quarter posted a collective loss of $3 million on $24.5 million in revenue. That compares with operating earnings of $1.2 million on revenue of $26.2 million for the bundle of services GST sells over its network, and earnings of $29 million on revenue of $46.6 million for block sales of capacity on its network.
GST executives had said they would cut losses from the legacy units in the third quarter, but "they surprised investors on the down side," says Mr. Conrad. After a one-time gain from a lawsuit settlement, the company narrowed its third-quarter loss to $5.3 million, or 14 cents a share, compared with a year-earlier loss of $1.76 a share. However, nine analysts surveyed by First Call/Thompson Financial had expected a loss of only 10 cents a share, including the one-time gain. And excluding the gain, the loss was $33.1 million, or 89 cents a share.
That is troubling for a company with nearly $4 in debt for every $1 of sales. Wall Street expects the company to post a loss of $4.93 a share this year, according to the First Call/Thompson Financial consensus of analysts' estimates.
Mike Renegar of Banc of America Securities in New York, agrees that GST's marginal businesses are what is holding the stock price down. GST shares trade at only 2.0 times the value of the company's plant and equipment, compared with a multiple of 6.1 for competitor Nextlink, Bellevue, Wash., and 6.3 for RCN Communications, Princeton, N.J.
Meanwhile, a shareholder lawsuit filed Oct. 22 in U.S. District Court in Seattle is weighing on the shares, too. But Mr. Renegar doesn't believe the suit will hurt the company's prospects. The suit alleges that GST defrauded investors by not disclosing all the terms of its spin-out of the Global Light assets to a group of buyers led by former chief executive officer John Warta.
GST says that the lawsuit is unfounded and that the company will seek its dismissal. The same transaction was the focus of a lawsuit that GST filed against the buyers late last year in Santa Clara County Circuit Court in California. That suit alleged that the individuals and Global Light conspired to illegally transfer GST's 49% interest in a Mexican telecommunications venture to Global Light.
Without admitting any wrongdoing, the buyers settled out of court and agreed to pay GST $30 million.
Based on that earlier settlement, the new suit isn't likely to produce any surprises, says Mr. Renegar. "The skeletons are all out of the closet."
The company's finances, however, could remain a challenge for the next several years. GST has $175 million in cash, but its expansion plans in 2000 alone call for spending as much as $200 million. With interest rates rising, selling more debt is an unattractive prospect, so GST has hired investment bankers Deutsche Banc and Bear Stearns to help it find partners or other investors. The company also will have to absorb higher administrative costs as it increases its sales staff to 330 early next year from 253 now.
And investors face potential dilution in the spring when the preferred shares held by Princes Gate convert to 5.9 million shares of common stock at $13.33 a share. That is a 15% dilution to the 37.6 million shares already outstanding.
Still, investing at the current price of $8.50 presents only a modest risk, says Aryeh Bourkoff of CIBC World Markets in New York, who rates the shares a "buy" with a price target of $21 by next fall.
GST's bundle of business telecommunication services for voice, data and Internet access will continue to take market share away from local phone providers SBC Communications of Houston and U S West of Denver, Mr. Bourkoff says. And its fiber-optic network is well-positioned to serve the growing number of West Coast dot-com companies, he says.
By the middle of next year, Mr. Basile, GST's president, would like to carry 40% of GST's old long-distance business over its fiber network, up from 25% today. But, he says "the larger opportunity" is to take away business customers from U S West and SBC Communications, which serve more than 90% of the market today.
Lots of people want a chunk of that business, he says, which "may give us an opportunity to be part of a larger company through an acquisition." But GST isn't currently talking to any suitors, he adds.
GST's temporary ills won't change the growing demand for communications capacity, says Mr. Basile. "That's our future. If you peel the onion, you'll see that future is sound." |
